Conceptual Basis for

Accounting
Module 1
Dr. S. Nagalakshmi
Understanding Business Organizations
• The definition of business purpose and business mission, there is only one focus,
one starting point. It is the “CUSTOMER”.
• The customer delivers the business.
• Business organizations bring together materials, technology, people and money in
order to satisfy their customers needs and thereby seek to earn a profit.
• They provide products and services
• Merchandising (or trading) organizations such as Pantaloons, Wal-Mart, Amazon
buy and sell products.
• Manufacturing organizations make products like Sony and Boeing.
• Service organizations such as State Bank of India, Lakme Beauty Salon provide
professional or personal services.
• They perform complex operations.
• They are cash generating-cum-dispensing machines.
• For e.g. Nzyme Company produces fermentation agents for food and
beverages.
• It hires buildings and equipment, employs scientists and other
professionals.
• It receives cash for sales – Past, present and future.
• Pays for salaries, materials, office and factory expenses, tax, distribute
a part of the surplus cash to its owners.
Nzyme Company
Cash Receipts Cash Payments
Customers past sales Employee salaries, benefits
Current sales Suppliers
Future sales Lenders
Government taxes
Owner, dividends
Forms of Business Organization
• 1. Sole proprietorship – single individual carries on a business
• 2. Partnership – minimum of 2 and maximum of 100
• 3. Company – Legal entity, has most of the rights of a natural person.
• Private limited company – minimum of 2 and maximum of 200 shareholders. Shares
are not available to the public. They have private limited as part of their names
“FANUC India Private Limited”.
• Public Limited company – minimum 7 and no maximum limit. Shares are available to
the public. They have limited as part of their names “Hindustan Unilever Limited”.
• 4. Limited Liability Partnership – created by LLP Act 2008, is a hybrid between a
company and a partnership. It is a separate legal entity with perpetual existence,
similar to a company.
• It can individuals and corporate bodies as partners and liability is limited to their
shareholdings.
Organization Structure
• Chart
Accounting
• Is it mandatory that everyone should know accounting?
• Why you should know accounting?
Reasons
• Since a company’s financial statements affect stock prices, a manager should
know accounting.
• One plan to be in corporate strategy. Without accounting numbers strategy
won’t make sense.
• Want to be an investment banker, then use accounting information to value firms
• Want to be in marketing, then profitability analysis is important.
• Want to do start-up, then you should know managing accounting and financing
function.
• Using financial numbers one can analyze cases in Marketing, operations and
strategy better.
• The Law requires CEO and CFO to ascertain the financial position
• Managers have the responsibility to provide truthful, relevant and timely
information. It should be trustworthy and for this they should have a sound
understanding of financial statements.
Accounting Information System
• Accounting is an information system. Like any system, it converts inputs
into outputs using processes.
• Business transactions and events are the input of the accounting
system. Salaries payment, collection from customers, payment of taxes
etc are business transactions.
• The accounting process involves applying policies, assumptions, laws.
• For e.g. What should be the life of a computer for accounting purposes?
• What information should a business disclose to its investors?
• The output includes financial statements, tax returns and regulatory
filings.
Inputs Processing
Business transactions (e.g Accounting principles and
purchases sales) standards
External events (fire, change in tax Management assumptions and
law, government take over of assets estimates
Laws and regulations

Users Output
Shareholders Statement of profit and loss
Equity and credit analysts Statement of retained earnings
Banks Balance sheet
Managers Cash flow statement
Employees Statement of changes in equity
Suppliers Explanatory notes
Customers, Government and Management commentary
Regulators Tax returns
• Accounting information and Economic Decisions
• It is helpful in making a number of decisions that result wealth
creation of individuals and organizations.
• Information is given in a language can be useful only to persons who
understand that language.
• Financial and Management Accounting
• The accounting system provides information to persons inside and
outside the enterprise.
• Financial accounting is for outsiders whereas management accounting
is to help managers plan and control operations.
• It is more detailed and timely than what is available to external users.
Users of Accounting information
• Investors
• Lenders
• Managers and directors
• Employees, trade unions
• Suppliers, trade financiers
• Customers
• Auditors
• Government regulatory authorities
• The Public
Accounting Principles
• The information contained in financial reports should be reliable and
intelligible.
• Besides, we should be able to make meaningful comparisons between
a firm’s past financial history and the financial information of other
firms.
• Therefore we need a body of concepts and a set of practices to guide
business enterprises in preparing financial reports.
• The conventions, assumptions, concepts and rules which define
accepted accounting practice constitute GAAP (Generally accepted
accounting principles)
GAAP
• It represents the fundamental positions that have been generally agreed upon by
accountants and encompasses contemporary permissible accounting practice.
• It assures the reliability and comparability of accounting information. They have
evolved in response to the needs of the users of information.
• We will begin with the following conventions or assumptions that underlie accounting
measurement in GAAP.
• Separate legal entity – Reporting entity – Business and personal should be separated;
Legal entity (standalone) ; Group (consolidated); Segment ( diversified product details)
• Going concern
• Historical cost
• Periodicity
• Money measurement
Institutions that regulate Indian accounting
• Ministry of corporate affairs
• National Financial Reporting Authority
• SEBI
• Institute of Chartered Accountants of India
• Income Tax authorities
• Comptroller and auditor General of India
• Insurance regulatory and development authority of India
• RBI
• International accounting standards Board
• International Federation of Accountants
Definition of Accounting
• It is the process of recording, classifying, summarizing and analyzing
the financial transactions and communicating the result thereof to
the persons interested in such information. Steps are as follows:
• Recording the transactions
• Classifying the transactions
• Summarizing the transactions
• Interpreting the transactions
• Communication of results
Objectives of Accounting or Need for
Accounting
• Systematic recording of transaction
• Ascertainment of results of above recorded transactions
• Ascertainment of the financial position of the business
• Providing information to the users for rational decision-making
• To know the solvency position
Basis of Accounting
• Cash Basis of Accounting
• Mercantile Basis of Accrual
Basis
Branches of Accounting
• Financial Accounting
• Cost Accounting
• Management Accounting
Accounting Cycle
• Recording of
transaction in journal
or subsidiary books
• Posting them to various
ledger accounts
• Preparation of trial
balance from ledger
accounts
• Preparation of final
accounts
Accounting Equation
• It shows the relationship between the economic resources of a business and the
claims against those resources. At all times, the following relationship holds:
• Economic resources = Claims
• Economic resources are assets.
• Claims = creditors claims or liabilities and owner’s claims or equity.
• Therefore modified accounting equation will be
• Assets = Liabilities + Equity
• We can analyze any business transaction, regardless of its size and complexity, in
terms of its effect on the accounting equation.
• The balance sheet shows the position of assets, liabilities and equity.
• Assets = It is a resource that gives benefits to its owner. An asset is what
an enterprise owns.
• Liabilities = It is an obligation that requires to be settled by giving up
assets. It is what an enterprise owes.
• Equity = It is net assets i.e., difference between an enterprise’s assets
and its liabilities.
• The equity of a company is called shareholder’s equity which includes
share capital, securities premium and retained earnings.
• Revenues
• Expenses
• Net profit/net loss
• Dividends
• Retained earnings.
Financial Performance through accounting
equation
• Assets = Liabilities or
• Assets = outside liabilities plus owner’s capital or
• Assets – outside liabilities = owner’s capital or
• Assets – outside liabilities = owner’s capital – drawings + profit – loss
• Assets – outside liabilities = owner’s capital – drawings + income –
expenses.

• Verification of Balance Sheet identity / Basic accounting equation

through Radhika Enterprises.
Business transactions – On March 1, 2019, Suresh starts softomation as a proprietorship for
providing software services. The business engaged in the following transactions in March: Show
the effect on Accounting equation.
2019 Suresh begins business with cash Rs. 50,000.
March 1

2 Takes a loan from Manish Rs. 20,000

3 Buys a computer for cash Rs. 58,000
6 Buys supplies on credit Rs. 6,000
9 Sells software for cash Rs. 12,000
12 Pays for a part of the supplies bought on March 6, Rs. 2,000
17 Uses supplies for personal purpose Rs. 1,000
23 Returns defective supplies for immediate refund Rs. 1,900
26 Pays salaries Rs. 4,000 and office rent Rs. 1,200
29 Sells software on credit Rs. 8,000
30 Withdraws cash for personal use Rs. 3,500
31 Uses supplies for business purpose Rs. 1,400
Financial Statement
• Financial Statements provide information about an enterprises
financial position and financial performance.
• Financial statements present the financial effects of transactions and
other events by grouping them into broad classes or elements.
• Assets, liabilities and equity are the elements related to the
measurement of financial position.
• Revenue and expenses are the elements related to the measurement
of performance.
• There are four major financial statements:
Financial Statements
• The balance sheet shows the financial position at a point in time
• The statement of profit or loss reports the financial performance in a
period
• The statement of changes in equity explains how equity changed as a
result of net profit, dividends, return on capital and other transactions
in a period.
• The statement of cash flows summarizes the cash inflows and
outflows resulting from operating, investing and financing activities in
a period.
• Statement of changes in Equity:
• It describes the changes in the equity items e.g., share capital and
retained earnings in a period.
• Changes in share capital result from introduction or withdrawal of
capital by the owners. Changes in retained earnings result from net
profit and distribution to the owners.
• Statement of cash flows:
• It reports the cash effects of an enterprise’s
• a. operations (providing goods and services)
• B. investments (buying and selling assets)
• C. financing (raising and repaying funds) in a period.
Financial statement analysis - Basics

• Suresh wants to know how his new business did in the first month. Here are
some key questions:
• Is business making good profit from sales? ( ratio of profit to sales)
• Is business earning a reasonable return on investment? (ratio of profit to assets)
• Is business using its assets efficiently? ( ratio of sales to assets)
• Are customers taking too long to pay? ( ratio of receivables to sales)
• Will business be able to pay its suppliers on time?
• Is suresh earning a reasonable return on his investment? ( ratio of profit to
equity)
• Does suresh have sufficient skin in the game? (debt equity ratio and drawings)
• Is business profit real? Cash from operations
• What risks? (investment in equipment is huge, terms of loan, no loan means
cash deficit)
Problem 2

On January 1 2022, Manohar started Qualphoto company. The following transactions took place during the
first month.

Jan 1 Manohar invested Rs. 30,000 cash in the company’s share capital (shares of Rs. 10
each)
2 Bought supplies of photographic materials on credit Rs. 9000
5 Bought photographic equipment for cash Rs. 12,000
7 Received fees for photographic services Rs. 15,000
13 Paid creditor for supplies Rs. 5,000
18 Manohar invested further Rs. 12,000 cash in the company’s share capital
22 Billed customers for services
27 Paid office rent Rs. 2500 and electricity charges Rs. 1200
30 Paid dividends Rs. 4,000
31 Prepared the monthly payroll to be paid on Feb 1, Rs. 11,500.
Required
1. Analyze the effect of these transactions on the accounting equation.